"To know that I do not know what I know, and that I do not know what I do not know…that is true knowledge. -Confucius

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One of the areas I particularly enjoy exploring is our fallibility as a species. Humans are not only bad at understanding our own minds, but we have a problem even recognizing where we may be ignorant or lacking.

This is peculiarly relevant for investors and traders.

What started me thinking about this today was an Op/Ed by Richard Fortey, senior paleontologist at the Natural History Museum in London, about natural disasters, Blind to the End:

"Human beings are never prepared for natural disasters. There is a kind of optimism built into our species that seems to prefer to live in the comfortable present rather than confront the possibility of destruction. It may happen, we seem to believe, but not now, and not to us. There is nothing new in this attitude."

Altough Fortey is referring to natural disasters, he could just as easily ahve been referencing the mindset of investors. All too often, their portfolios seem to get
blindsided by wholly unexpected events, rather
than anticipated problems. (I’ve addressed this in the past: Folly of Forecasting, Know Thyself, and Expect to Be Wrong).

In other words, we have a blindspot for our own blindspots.

Taleeb Nassim’s "Fooled by Randomness" refers to these dislocations as Black Swan events. Despite their regular occurences — be it market crashes or earthquakes — we tend to think of them (if we think of them at all) as far rarer than they actually are.

That’s due or our sense of time and place. I’ve noted in the past the issue of time scale and market cycles. We have a problem thinking in terms of millenia, centuries, or even in years. Fortey makes specific reference to this, observing:

"The time-scale is our conceptual problem. Tectonic events happen on a scale of hundreds to millions of years. Most humans find it hard to think beyond the life spans of their grandchildren. There is a psychological fault line between the human and the natural calibration of the world. Incomprehension fosters a kind of rose-tinted amnesia. If anything, the comparative comfort of modern (at least Western) life makes disasters the more unthinkable. We don’t want to know."

All this relates back to my bearish call for 2006. What I plan to do this week, as a ramp up to a fuller exposition on the subject, is map out several different longer term historical views. These charts may shed some insight into why a dislocation — a "Black Swan event" — is increasingly likely.

It also reveals why the long term is so challenging for people to intuitively grasp — its simply not in our nature.

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Source:Blind to the End RICHARD FORTEYNYT, December 26, 2005http://www.nytimes.com/2005/12/26/opinion/26fortey.html

Blaise Pascal (1623–1662):

Nec me pudet, ut istos, fateri nescire quid nesciam(“I am not ashamed, as your friends are, to confess that I do not know what I do not know.”)

Clarence Darrow, during the Scopes Monkey Trial:

"Science gets to the end of its knowledge and, in effect, says, ‘I do not know what I do not know,‘ and keeps on searching. Religion gets to the end of its knowledge, and in effect, says, ‘I know what I do not know,’ and stops searching.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “How Blind Are We to Our Own Shortcomings?”

He who knows not, and knows not that he knows not, is a fool; shun him.
He who knows not, and knows that he knows not, can be taught; teach him.
He who knows, and knows not that he knows, is asleep; wake him.
He who knows, and knows that he knows, is a prophet; follow him.

I read this bit of wisdom at the languagelog.org post No Foot In Mouth, which was written to rebut the criticism of Rumsfeld’s known knowns speech. While I like Rumseld’s logic and English, I am remaining silent on the overall policy issues.

I just thought the Persian apothegm was a nice compliment to your Confucius quote.

I have read a few market analysts and economists who believe that when the housing slowdown is confirmed Bernanke will start both the rate reduction process as well as adding substantial liquidity to the system through securities purchases. Now, some feel the bond market is already anticipating it with yields flat to trending down, others feel that yields will take off as the bond vigilantes return. And as rates go, so do the rest of the markets.

What are your thoughts on Fed action and rates? I think it is more complex as the most recent Fed ease has led to negative real rates and liquidity, fueling debt based consumption here in the US and profitless capital spending and capacity addition in China. So, assuming Bernanke returns to the liquidity priming posture, how much more capacity can be constructed in China and what new or existing asset remains to be levered-up in the US?

Yeah, but most progress springs of hope and optimism, and taking risks in confident expectation of favorable outcome. “Hope for the best, but be prepared for the worst.” The difficult part is where to make the cut in expectations of the worst. There is such a thing as excessive protection. And of course, on the other side, overconfidence.

When it comes to economic endeavors, I have a vague sense that many potential “fundamental” risk takers (subject-matter innovators) cannot expect to reap risk-adjusted positive returns in the current environment, and this begets a vicious circle of risk aversion and risk shifting efforts, expressing itself in increased focus on financial & legal maneuvers instead of working on a subject matter.

However, I think Bruce Lee had a far better grasp of markets than Confucius when he said:

“Empty your mind, be formless, shapeless like water. If you put water into a cup, it becomes the cup. You put water into a bottle, it becomes the bottle. You put it in a teapot, it becomes the teapot. Now, water can flow or it can crash. Be water my friend.” – Bruce Lee

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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